The Biggest Opportunity of 2023 Awaits You
Imagine being able to invest in top-quality real estate at an unbeatable price of just 50 cents on the dollar. It sounds too good to be true, right? But what if I told you that this incredible deal also comes with passive income, liquidity, diversification, limited liability, and highly efficient management? That's exactly what the REIT (VNQ) market is offering today.
REIT share prices crashed in 2022 and they are now priced at steep discounts relative to the fair value of the real estate they own.
The last two times they were so cheap were following the Great Financial Crisis and the Pandemic. Both times, savvy investors made fortunes in the aftermath as REITs nearly tripled in less than two years following the Great Financial Crisis, and more than doubled in just over a year following the Pandemic:
Today, the market conditions are reminiscent of 2008, with REITs heavily discounted and offering the potential for substantial returns in the years ahead:
The opportunity is so big that even the biggest private equity players, like Blackstone, are loading up on them. They bought $10s of billion worth of REITs shortly after making the following remarks in 2022:
"Market volatility is creating opportunities, including several public company situations." - Jonathan Gray, President/COO, Blackstone Q1 2022 Earnings Call
"The best opportunities today are clearly in the public markets on the screen and that's where we're spending a lot of time." - Jonathan Gray, President/COO, Blackstone Q2 2022 Earnings Call
They invest so heavily in REITs because they essentially allow them to buy real estate at a steep discount to its fair value.
Of course, it isn't possible to predict what the market will do in the short run, but in the long run, it has always been a good idea to buy high-quality REITs when they were offered at such low valuations.
5 years from now, I predict that many of these REITs will trade at much higher share prices because I expect interest rates to eventually return to lower levels as we get the inflation back under control... but rents will now remain at persistently high levels, resulting in record cash flows and valuations.
Today, you get to buy REITs at discounted prices while everyone focuses on the rising interest rates, but this narrative will change again because the positive impact of high inflation is ultimately a lot greater than the negative impact of rising interest rates.
Here are two REITs that you will probably wish you grabbed 5 years from now:
Crown Castle (CCI)
CCI is potentially the highest-yielding blue-chip high-growth REIT in the entire marketplace right now.
Historically, its yield has been in the 2.5-3.5% range during most times, which makes sense for an investment-grade rated blue-chip REIT that invests in cell towers. But following its recent dip and its 6.5% dividend hike, it now yields more than ever at nearly 5%.
The market has repriced CCI at a higher dividend yield because it is expected to grow slower than usual in the coming years. The management has been open about their slow-down and hasn't tried to hide from the market.
The reason why its growth is slowing down is that CCI had some lease cancellations after T-Mobile bought Sprint. Tower REITs profit when they can add additional tenants to a tower, but this also means that they suffer from carrier consolidation. Previously, CCI may have leased space to both, T-Mobile (TMUS) and Sprint, but it will lose the revenue coming from Sprint going forward as leases expire.
This will be a headwind in the next few years, but even despite that, CCI is still expected to keep growing, albeit just at a lower rate.
More importantly, what the market appears to forget is that this is just a temporary headwind. Here is what the CEO commented on their most recent conference call:
So to wrap up, we are excited about the strength of our business and our ability to execute on our strategy to deliver the highest risk-adjusted returns for our shareholders by growing our dividend over the long-term and investing in assets that will help drive future growth. We have delivered 9% compound annual and dividend per share growth since we established our 7% to 8% dividend per share growth target in 2017. And I believe that we are positioned well to return to 7% to 8% dividend per share growth as we move beyond the Sprint decommissioning impacts in 2025.
So they expect slower growth for just 2 years. After that, they expect to return to their 7-8% annual dividend growth target, which they have historically outpaced:
High-quality REITs like CCI that are able to grow their dividend at 7-8% per year are typically priced at closer to a 3% dividend yield. To return to that yield level, its share price would need to appreciate by 50%, and while you wait you earn a 4.5% dividend yield that's safe and growing. The shares are also priced at a 30% discount to NAV, which is very unusual for a blue chip like CCI.
It is hard to beat that in terms of risk-to-reward and this is why we are today making CCI the largest holding of our Retirement Portfolio.
Alexandria Real Estate (ARE)
Alexandria Real Estate is the only REIT that specializes in life science buildings and it currently represents 12.56% of our Retirement Portfolio.
We invested so heavily in it because:
- It owns very attractive assets: Life science buildings can be great investments because (1) there is high and growing demand for space as lots of money is pumped into research, especially in the post-covid world, but the supply of space is limited and the barriers-to-entry are greater than for other properties. To build new properties, you need specialized skills, relationships, and getting permits is also harder. (2) This has historically resulted in rapid rent growth and high occupancy rates. (3) Tenant relocations are also rare because it is impractical to move the equipment/set up. Over the past 5 years, Alexandria retained >80% of its existing tenants at the time of lease expirations and was able to push for large rent hikes in most cases. (4) The credit quality of tenants are strong. 90% of its top 20 tenants are investment-grade rated or public companies. (5) Its rents are today deeply below market, providing margin of safety and a "bank of growth" for the future.
- It has a fortress balance sheet: Alexandria has one of the strongest balance sheets in the REIT sector with a low 25% LTV (incl. preferred equity), 99% fixed rate, and a long 13.2 year average term with no maturities until 2025, and over $5 billion of liquidity available to pay of future maturities if needed. It also retains a lot of cash flow with its low 52% payout ratio. It then isn't surprising that it has a BBB+ credit rating. Its leverage is now at an all-time low and it probably isn't far from earning an A- credit rating.
- It was (and remains) discounted: We estimate that the shares are priced at a 30% discount to its net asset value and 16x its 2023 FFO. That's on the low side for a REIT with such a strong balance sheet, resilient properties, and predictable growth prospects. We believe that it should trade at closer to 22x FFO, which would bring its share price closer to $200 per share. It traded at $220 in early 2022 when its cash flow was 10% lower. Yet, it is today priced at just $143 per share. We think that one reason why Alexandria is discounted is that it is generally included in the "office" peer group and it hurts its market sentiment. In reality, traditional offices and life science buildings have completely different fundamentals.
- It pays a rapidly-growing dividend: The dividend yield is not particularly high today at 3.4%, but the payout ratio is low at 52%, and the company's cash flow is growing rapidly. Over the past 5 years, the average annual dividend hike has been 6.5% and we think that this could accelerate in the future as they increase their payout ratio.
- It has a great track record: Owning Class A life science buildings is attractive on its own, but Alexandria does not stop there. It creates additional value by developing its own properties. It is able to develop new properties at a 6-7% stabilized yield, but these assets can then be sold at a 4-4.5% cap rate, creating lots of value for shareholders. Moreover, Alexandria also has a Venture capital arm, buying equity stakes in some of its tenants and these investments have been very successful in the past. Being the biggest landlord in the life science space gives it a competitive advantage for venture capital investments because it has relationships with most biotech companies. All of this has resulted in market-beating returns since going public, outperforming even Berkshire Hathaway (BRK.B) and Walmart (WMT):
Just the other day, the company released its full-year results and issued its guidance for 2023. Typically, we don't post updates immediately after earnings come out because we like to wait to see the results of peers to compare results.
But Alexandria doesn't have peers, and besides, this is our largest position, so we figured we would provide an update since many of you have asked me questions.
The main takeaway here is that Alexandria keeps performing very well and we are reaffirming our Strong Buy rating:
Firstly, the growth remains exceptionally strong:
- FFO per share rose by 8.5% in 2022, all while the company deleveraged its balance sheet.
- Its rents were hiked by 22% on lease renewals, the second-highest growth rate in the company's history.
- Its leasing volume was also the second highest in the company's history in 2022, demonstrating strong demand, and its occupancy rate rose slightly.
- Its development pipeline is largely pre-leased already, reducing risk and providing a predictable path to further growth.
- The company is guiding growth to continue in 2023 with a 5-6% FFO per share growth rate. This is a bit less than in 2022, but keep in mind that 2022 FFO came ahead of expectations.
Secondly, the balance sheet is now stronger than ever before and they continue to have good access to capital to grow externally even despite the discounted share price and the higher interest rates:
- Net debt and preferred stock to Adjusted EBITDA of 5.1x, the lowest ratio in Company history.
- They have no debt maturities in 2023 or 2024.
- They can access equity by selling stabilized assets at low cap rates and reinvesting the proceeds into higher-yielding development projects. In 2022, they sold $2.2 billion worth of assets at a 4.4% average cap rate, realizing a gain of $1.2 billion (!!!).
- They have a low payout ratio of 52%, which allows them to pay off debt and/or reinvest in growth organically:
Finally, its valuation remains discounted. Its share price is up a bit lately, but this is well-justified when you consider that the bear thesis hasn't played out.
Here's what the CEO said on the most recent earnings call:
Now looking back at 2022, the stats truly speak for themselves regarding the enduring strength of the life science industry. First, despite widespread commentary that VC funding hit the pause button in 2022, life science venture deals totaled nearly $58 billion.
Other than 2021's record year, it was the second highest amount of capital ever deployed. Of note, over 70% of VC dollars deployed went into an Alexandria cluster, and with VC funds across tech and life science raising nearly $160 billion in 2022, a record eclipsing 2021 is $150 billion, significant dry powder is on hand to deploy over a multiyear time horizon. [emphasis added]
Interestingly, this strong growth is reflected in the share prices of pharma companies, but not in that of Alexandria:
Second, large pharma continues to be one of the best performing sectors in the market. In a year where total returns for market indices such as the NASDAQ and Dow ended the year down 10%, the top 20 biopharma ended the year up an average 12%, with 8 of the top 20 pharma ending the year with total returns over 20%. With historic levels of cash on hand, over $300 billion to deploy into R&D and M&A, biopharma has the firepower to continue to innovate and grow. [emphasis added]
We think that this huge disparity is an opportunity.
Alexandria directly profits from the growth of these companies as it results in more demand for space, new development opportunities, and higher rents.
But Alexandria appears to have sold off with the rest of the REIT market as if it was going to suffer from rising interest rates and a recession, which isn't the case. It actually sold off even more than the rest of the REIT sector, despite enjoying better growth prospects and having one of the strongest balance sheets:
So with that in mind, we are happy to keep Alexandria as one of the largest positions in our Retirement Portfolio.
We believe that its fair value is around $200 per share and you can buy it today at $160. We expect its fair value to keep growing rapidly in the long run, providing a path to 13-16% annual total returns with below-average risk in the years ahead.
3.4% dividend yield + 5-8% annual growth + 5% annual repricing upside
= 13-16% annual total returns
Most investors appear to ignore that REITs aren't materially impacted by rising interest rates because their balance sheets are the strongest ever with a low 35% LTV on average and long debt maturities at 8 years. In many cases, these REITs won't feel any impact for many years to come.
Meanwhile, their rents keep on rising as a result of the high inflation and dividends keep getting hiked.
Eventually, the narrative will change and the time to invest is now while everyone else is fearful.
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How long should you hold REITs? ›
REITs should generally be considered long-term investments
This is especially true if you're planning to invest in non-traded REITs since you won't be able to easily access your money until the REIT lists its shares on a public exchange or liquidates its assets. In many cases, this can take around 10 years to occur.
"I believe that now is the optimal time to invest in REITs. The first half of 2022 is not reflective of the strong long term fundamentals in real estate. If you compare REITs to a high tech fund, the outperformance has been enormous," says Alex Snyder.Why you should avoid REITs? ›
Summary of Why Investors May Not Want to Invest in REITs
But, REITs are not risk free. They may have highly variable returns, are sensitive to changes in interest rates, have income tax implications, may not be liquid, and fees can impact total returns.
- Gaming and Leisure Properties Inc. (GLPI)
- Iron Mountain Inc. (IRM)
- Public Storage (PSA)
- Prologis Inc. (PLD)
- American Tower Corp. (AMT)
- Blackstone Mortgage Trust Inc. (BXMT)
- Realty Income Corp. (O)
- Easterly Government Properties Inc. (DEA)
Potential For Recession
Fitch's REIT outlook, however, is more tempered. The credit ratings agency predicts that recessionary conditions, higher capital costs, and waning demand in some sectors will keep REITs from outperforming in 2023.
For example, earning 11% annual total returns on a $300/month contribution would allow an investor to surpass $1 million after just 33 years. Setting aside $100 a month for each of these three real estate investment trusts (REITs) could make you a millionaire in the span of just over three decades.What is the outlook for REITs in 2023? ›
After facing performance headwinds in the past year, real estate investment trusts (REITs) could see some stabilization in 2023 if the pace of interest-rate increases slows. REITs that rent out residential apartments and homes, in particular, could fare strongest given current dynamics in the housing market.What are the safest REITs? ›
- American Tower Corp. (ticker: AMT)
- Crown Castle Inc. (CCI)
- Ventas Inc. (VTR)
- Welltower Inc. (WELL)
- Physicians Realty Trust (DOC)
- Healthcare Realty Trust Inc. (HR)
- Prologis Inc. (PLD)
|REIT SUBGROUP||AVERAGE ANNUAL TOTAL RETURN (1994 to 2021)|
Can You Lose Money on a REIT? As with any investment, there is always a risk of loss. Publicly traded REITs have the particular risk of losing value as interest rates rise, which typically sends investment capital into bonds.
What happens to REITs in a recession? ›
Normally during recessions, commercial real estate occupancy declines, corporate bond yields spike, REITs' interest expenses rise, tenants default or fall behind on rent, and rent rates decline or at least slow their growth.
Many investors believe a reasonable portfolio allocation to REITs is between 5 percent and 15 percent, and there are two research-based factors that support the idea that allocations to REITs in an optimally-diversified portfolio may be at the higher end of the scale for many investors.What is better than REITs? ›
Direct real estate offers more tax breaks than REIT investments, and gives investors more control over decision making. Many REITs are publicly traded on exchanges, so they're easier to buy and sell than traditional real estate.What is the downside of REITs? ›
The potential downsides of a REIT investment include taxes, fees, and market volatility due to interest rate movements or trends in the real estate market. REITs tend to specialize in specific property types.What is a good REIT dividend? ›
The average dividend yield for equity REITs is right around 4.3%. However, there are some high-dividend REITs out there that pay significantly more than average. The dividend yield on a REIT is based on its current stock price.How much should I invest in REITs? ›
The Cheapest Option: REITs—$1,000 to $25,000 or more
A REIT offers the investor a relatively high dividend as well as a highly liquid method of investing in real estate. Most real estate investments are not easy or quick to get out of. An exchange-traded REIT is. Moreover, you can start small with a little bit of cash.
REITs make it possible to invest in real estate without owning physical property. They're a suitable retirement investment for their strong dividends and growth potential. REITs can also offer more portfolio diversification.Is it risky to invest in REITs? ›
Compared to other investments such as stocks and bonds, REITs are subject to various risk factors that affect the investor's returns. Some of the main risk factors associated with REITs include leverage risk, liquidity risk, and market risk.Is a REIT better than owning property? ›
Today especially, REITs are a lot safer because their valuations are a lot lower than those of rental properties. REIT share prices have dropped a lot in 2022 along with the rest of the stock market (SPY), but real estate prices have yet to adjust lower in any meaningful way.Is it hard to sell a REIT? ›
Real Estate Investment Trusts (REITs) are typically easy to buy and sell because most of them are traded on public exchanges. REITs strive to provide high dividends and offer the potential for long-term appreciation, making them attractive to real estate investors.
What is the largest REIT in the US? ›
(NYSE: PLD) is the biggest of the big with a market capitalization of $112.16 billion. It acquires and develops large real estate properties in the United States and around the world.
But REITs aren't “perfect investments” either.
In fact, there are many ways you can fail as a REIT investor. According to NAREIT, REITs have returned 15% per year over the past 20 years.
The housing recession that began in 2022 will bleed into 2023 as elevated inflation and mortgage rates, coupled with stubbornly high building material construction costs, continue to take a toll on the housing industry and are expected to push the overall economy into a mild recession this year.How often do REITs pay out? ›
While some stocks distribute dividends on an annual basis, certain REITs pay quarterly or monthly. That can be an advantage for investors, whether the money is used for enhancing income or for reinvestment, especially since more frequent payments compound faster.What REIT does Warren Buffett own? ›
Warren Buffett invests in a wide range of industries through the conglomerate Berkshire Hathaway (NYSE: BRK. A) (NYSE: BRK. B), real estate included. Yet only one real estate investment trust (REIT) holds a position within its portfolio: Net lease REIT STORE Capital (NYSE: STOR).What REIT pays the highest dividend? ›
- Chimera Investment Corporation (NYSE: CIM) - Dividend Yield 16.45% ...
- Annaly Capital Management, Inc. ( ...
- New York Mortgage Trust, Inc. ( ...
- Ellington Financial Inc. ( ...
- Necessity Retail REIT Inc (NASDAQ: RTL) - Dividend Yield 13.11%
When choosing what REIT to invest in, make sure you know the management team and their track record. Check to see how they are compensated. If it's based upon performance, chances are that they are looking out for your best interests as well. REITs are trusts focused upon the ownership of property.How much should a REIT be in a portfolio? ›
In general, a good rule of thumb is that REITs should not make up more than 25% of a well-diversified dividend stock portfolio, depending on your individual goals (such as what portfolio yield and long-term dividend growth rate you're targeting, and how much volatility you can stomach).What is the best asset in a recession? ›
Large cap stocks
- Personal care products.
REITs have performed remarkably well after periods of downturns. We analyzed recessionary periods dating back to 1990. This analysis shows that the best returns for REITs have been generated investing during the early cycle.
Should I invest in REIT during recession? ›
Investors worried about a recession can consider investing in Real Estate Investment Trusts (REITs). REITs own and operate income-producing real estates such as apartments, warehouses, self-storage facilities, malls, and hotels.What is the best investment right now? ›
- High Yield Savings Accounts.
- Short-Term Certificates of Deposits.
- Short-Term Government Bonds Funds.
- S&P 500 Index Funds.
- Dividend Stock Funds.
- Real Estate & REITs.
Individuals can invest in REITs in a variety of different ways, including purchasing shares of publicly traded REIT stocks, mutual funds and exchange-traded funds. An individual may buy shares in a REIT, which is listed on major stock exchanges, just like any other public stock.Why rental properties are better than REITs? ›
One very important difference to consider is that rental property is an active investment, while REITs are a passive investment. Rental property requires a hands-on approach and constant attention, even if you hire a management company to make most of the day-to-day decisions.Does Warren Buffett own rental property? ›
Buffett may not invest in rental properties, but he occasionally invests in real estate investment trusts ("REITs"), which are publicly listed real estate investment firms.How do you make money with REITs? ›
Earning money from a publicly owned real estate investment trust (REIT) is like earning money from stocks. You receive dividends from the profits of the company and can sell your shares at a profit when their value in the marketplace increases.Is a REIT taxable? ›
The majority of REIT dividends are taxed as ordinary income up to the maximum rate of 37% (returning to 39.6% in 2026), plus a separate 3.8% surtax on investment income. Taxpayers may also generally deduct 20% of the combined qualified business income amount which includes Qualified REIT Dividends through Dec.Are REITs better than mutual funds? ›
Real estate mutual funds are managed funds that invest in REITs, real-estate stocks and indices, or both. REITs tend to be more tax-advantaged and less costly than real estate mutual funds.What is the average REIT dividend? ›
As of August 31, 2022 publicly traded U.S. equity REITs posted a one-year average dividend yield of 2.91 percent.Is it hard to get out of a REIT? ›
Getting out of a non-traded real estate investment trust, or REIT, can often be rather difficult and expensive. Once a REIT is closed to new investors, the board of directors of the REIT can suspend the redemption policy.
How much of portfolio should be in REITs? ›
Many investors believe a reasonable portfolio allocation to REITs is between 5 percent and 15 percent, and there are two research-based factors that support the idea that allocations to REITs in an optimally-diversified portfolio may be at the higher end of the scale for many investors.How long should I hold my investment property? ›
With buy-and-hold real estate, an investor will typically purchase a rental property, hold it for 5 years or more, and refinance or sell when and if the time is right. This is often done alongside short-term strategies, like fixing and flipping properties. Some buy-and-hold real estate investors rarely sell.What is a good return on a REIT? ›
Return a minimum of 90% of taxable income in the form of shareholder dividends each year. This is a big draw for investor interest in REITs.Are REITs safer than stocks? ›
While stocks traditionally have the highest potential for reward over time, they're also the riskiest, and as stock markets plummet around the world, we can see that high risk investments aren't necessarily the best way to get higher returns. So for long term investments, REITs win.What is the REIT 5 50 rule? ›
A REIT will be closely held if more than 50 percent of the value of its outstanding stock is owned directly or indirectly by or for five or fewer individuals at any point during the last half of the taxable year, (this is commonly referred to as the 5/50 test).Do REITs do well in a recession? ›
REITs have performed remarkably well after periods of downturns. We analyzed recessionary periods dating back to 1990. This analysis shows that the best returns for REITs have been generated investing during the early cycle.Is REIT good for retirement? ›
Few asset classes are better suited to retirement portfolios than real estate. Few asset classes are better suited to retirement portfolios than real estate. If managed sensibly, a portfolio of real estate investment trusts (REITs) can provide a steady stream of retirement income that will last a lifetime.When should you walk away from investment property? ›
As an investor, you should only go for positive cash flow properties with a good return on investment. If the investment property deal finder reveals that a house will generate negative cash flow, walk away quickly.What is the 1 rule for investment property? ›
The 1% rule of real estate investing measures the price of the investment property against the gross income it will generate. For a potential investment to pass the 1% rule, its monthly rent must be equal to or no less than 1% of the purchase price.Is it worth keeping a rental property? ›
Owning a rental property is a safe investment and an even better asset that can make money during periods of high inflation. It gains value when inflation is high and creates cash flow from renting during any economic period. It's really a win-win.